On Friday, September 11, the core issue in the euro exchange rate market shifted from "whether the European Central Bank (ECB) will raise interest rates" to "who will maintain restrictive policies for longer, the ECB or the Federal Reserve?" The ECB raised its three key interest rates by 25 basis points on September 10, with the deposit facility rate rising to 2.50%, effective September 16. The Eurozone's Harmonized Index of Consumer Prices (HICP) rose to 3.3% year-on-year in August, with the energy component increasing by 14.3% year-on-year. High oil prices and Middle East conflicts have refocused inflation risks on the supply side. The latest US August Consumer Price Index (CPI) was +0.4% month-on-month and +3.4% year-on-year, with the core index +0.3% month-on-month and +2.4% year-on-year.

The ECB's focus in raising interest rates is not on 25 basis points, but on the renewed upward shift in the inflation path.

The rate hike itself was largely expected; the real shift in pricing was driven by the ECB's assessment of the duration of inflation. The latest forecasts show that Eurozone overall inflation will average 3.0% in 2026, 2.5% in 2027, and 2.1% in 2028; real GDP growth forecasts are 0.9%, 1.4%, and 1.5%, respectively. Compared to June, inflation forecasts for 2027 and 2028 have been revised upwards, as have growth forecasts for 2026 and 2027. This does not imply an overheated economy, but rather that the combination of "high inflation but not yet stalled growth" increases the tolerance for continued policy restraint. Lagarde stated after the meeting that the decision received unanimous support and was a "no-hesitation" decision, while explicitly refusing to presuppose a direction for the next meeting. More importantly, she downplayed the market's mechanical understanding of the so-called neutral interest rate range, emphasizing that in a sustained shock environment, the neutral interest rate itself is difficult to identify precisely. This means that a certain model range cannot be considered a policy ceiling; the final interest rate still depends on inflation forecasts, the strength of transmission, and financial conditions.

Forward rate repricing is more important than the nominal interest rate level.

Following the rate hike, the money market initially priced in a further rate increase of approximately 60 basis points by April 2027, up from about 51 basis points before the meeting. This change is more informative than the "2.50%" figure itself, as foreign exchange prices trade on marginal changes in future interest rate differentials. The energy shock also brings an easily overlooked dual effect: it both raises Eurozone inflation and compresses real purchasing power and increases business costs. Therefore, higher interest rate expectations do not equate to a one-way positive for the euro. For exchange rates, it is necessary to observe nominal interest rate differentials, real interest rate differentials, growth differentials, and risk premiums simultaneously; no single variable is sufficient to explain all price changes. The ECB has also explicitly stated that the current risk mix presents an upward bias in inflation risks and a downward bias in economic growth risks, which is a typical policy dilemma.

The Federal Reserve also faces inflationary constraints, and the interest rate differential between Europe and the US is not a one-sided story.

The Federal Reserve's target range for the federal funds rate remains at 3.50% to 3.75%. Even using the European Central Bank's announced 2.50% deposit facility rate, effective September 16, the static policy rate is still higher. The US Producer Price Index (PPI) rose 0.4% month-on-month and 5.4% year-on-year in August, with non-farm payrolls increasing by 162,000 and the unemployment rate remaining at 4.1%. Latest consumer price data shows energy prices rose 2.1% month-on-month and gasoline prices rose 3.9%. These figures do not indicate a one-sided strengthening of the US economy, but rather suggest that the combination of inflation and employment keeps policy discussions cautious. Therefore, the statement that "the interest rate differential between Europe and the US supports the euro" must be understood on two levels. The first level is the static interest rate differential, which currently still favors the dollar; the second level is expected changes. If the upward revision of the European yield curve is greater than that of the US, the euro's relative interest rate discount will narrow, and vice versa. What truly needs to be tracked is the relative shift of the two curves, the term structure, and changes in real interest rates, rather than directly equating a central bank interest rate hike with exchange rate trends.

Technical analysis suggests that the impact of the event outweighs the trend signal.

The euro/dollar pair fell from above 1.16 to around 1.1593 around the time of the ECB decision, while the 200-day moving average was around 1.1635 before the decision. The current price is temporarily below the long-term moving average, which only indicates that the current price is below that average after the event and cannot independently predict the future direction. With the interest rate decision, energy prices, and US inflation data all converging, short-term volatility has increased, and moving averages, momentum, and overbought/oversold indicators are more susceptible to the impact of news-driven fluctuations. From a market microstructure perspective, the fact that the euro did not strengthen in tandem with the European Central Bank's interest rate hike indicates that previous expectations had already been largely priced in.

Frequently Asked Questions

Question 1: Why didn't the euro strengthen in tandem with the ECB's interest rate hike? Answer: Because the 25 basis point rate hike had already been largely priced in by the market. New information mainly came from inflation forecasts, growth forecasts, and subsequent policy statements. Exchange rate reactions depend on the difference between actual results and expectations, not just the rate hike itself. Question 2: Is the current interest rate differential between the US and Europe naturally favorable to the euro? Answer: Not necessarily. The Fed's policy rate remains higher than the ECB's, and the static interest rate differential still favors the dollar. The euro's relative interest rate support comes from the upward revision of the European yield curve and expectations of future interest rate differential changes, not from the current absolute interest rate level. Question 3: Why is oil price a significant variable for the euro/dollar exchange rate? Answer: Energy prices simultaneously affect Eurozone inflation, real income, business costs, and the ECB's reaction function, as well as US inflation and Fed pricing. Oil price shocks act on both ends simultaneously, ultimately impacting relative policy paths, real interest rate differentials, and bond yield spreads.